Fear of Floating: By Tying Their Currencies To The Dollar, Asian Governments are Creating Global Economic Strains

At least once a week I recieve an e-mail advocating a return to a system of fixed exchange rates. However the world does not have a completely floating system of exchange rates as there are still many currencies pegged to large currencies such as the U.S. Dollar.

A few Asian countries which have their currency pegged to the U.S. Dollar are causing strains in international markets according to a recent story in The Economist. While the U.S. Dollar has declined significantly in value relative to currencies such as the Euro and the Canadian Dollar, it has changed little against most Asian currencies. This is due to the fact that China and Malaysia have a fixed exchange rate with the U.S. Dollar and othre countries such as Japan and India have been selling their own currency on the open market and been buying U.S. Dollars, to keep the exchange rate stable. Asian countries wish to keep their currencies undervalued in order to be more competitive in foreign markets. However this cannot last forever and instead of a slow transition we would experience with a free market, we're likely to experience an abrupt and ultimately more painful transition.

For a more light hearted look at interest rates, you may also want to see the Economist's Big Mac Index

Important Links

• To learn more about how central bank reactions to inflation and deflation influence interest rates see "What is deflation".
• To learn about the link between exchange rates and interest rates see my "Guide to Exchange Rates".
• You may also want to see "The Canadian Exchange Rate" which details the performance of the Canadian Dollar during the first half of 2003.